LWR annual report: which profit do you look at?

Press, 24 October 1984, Page 30

LWR annual report: which profit do you look at?

By

CHARLES CARSLAW,

a senior lecturer in accounting at the University of Canterbury

In most company accounts a reader will find several different figures highlighted as profits such as “group profit before taxation, “group profit before the inclusion of associated companies,” “group profits before extraodinary items,” “net profits,” and several more. When readers of the accounts read the contents of directors’ and chairmen’s reports which talk about profit increases or examine the trends in graphs or statistics based on profits, it is most impotant to bear in mind which profit figure is being emphasised. A good example of this is the latest annual report of Lane Walker Rudkin, Ltd, for the year ended June 30. The annual report could well start with the headline that profits were up by 68 per cent on the previous year. That is, if you take the opinion that the most important figure from the point of view of the performance of the company and its staff is the profit-before-taxation figure which represents the income generated by the group on its normal operations. However, not all this profit belongs to the shareholders, since both the taxman and the independent shareholders of subsidiary companies must have their bit ahead of the company’s own shareholders. On an after-tax basis the profit before extraordinary items and associated companies is still up on the previous year, but by a smaller proportion at 25 per

cent from $5.7M in 1983 to $7.2M in 1984. The reason for this is that LWR suffered a small tax charge of SO.2M in 1984, compared with a SI.3M tax credit in the previous year. The less favourable tax situation is not unexpected on the increased trading profit but another factor to be taken into account is the company’s export incentives. These have not risen in line with the increased pre-tax profits and the investment allowances of the previous year are much reduced. They are still a substantial profit contributor at $2.5M, and LWR will have to make good use of the devaluation of the dollar if it is to offset the probable loss of these incentives in the future. For 1985, the accounts do state that they will still be adequately protected since the incentives have been in existence for at least part of the year. The next profit figure highlighted in the accounts is the “net profit before extraordinary items and minority interests.” This figure includes the effect of LWR’s share of profits and losses of associated companies in which it has a substantial interest. In comparison with last year the change from the previous period is not so favourable. This profit figure shows a small fall from the previous year. The cause: there was a net addition to profits of SO.BM in 1983 from the associated companies, but in 1984 there was a reduction of SO.7M from three associated companies: LWR Gent, Ltd,

Bing Harris and Company, Ltd, and Bickertori Holdings, Ltd. The main cause of these losses seems to arise from one of the members of the Bing Harris group, Bing Harris Sargood, Ltd, which was shut down this year after continuing losses. The figure may also include some of the losses from the Canadian joint-venture company which was also sold during the year after incurring losses, but this is not clear from the accounts. Either way one would expect these losses to end this year. From this profit figure is deducted the interest of the outside shareholders of LWR’s subsidiaries, which represents the profits of subsidiaries which do not belong to LWR. Principally, this will relate to M. O’Brien, Ltd, which is only 54 per cent owned by LWR. In the case of LWR the deduction for the minority interest is small and the group profit after tax before extraordinary items shows a small fall from the previous year.

This particular profit figure is the one considered most important by the directors and is the figure that they emphasise in their report. It is also used for the graphs and ratio computations in the report. The use of this profit figure has merit since it should represent a “normal” profit basis, but the decision of whether to include things above cr below this particular line is an important one since it will affect the whole emphasis of the report.

In LWR’s case what is below this line is big rind negative in both this year and the previous year. The group has extraordinary losses of ?2.7M this year to deduct from the net profit before extraordinary items of $6.4M. This leaves a net profit after tax and extraordinary items of $3.7M, which is a much more gloomy comparison being a sharp profit decline of 38 per cent from the S6.OM of the previous year.

Two major items make up these extraordinary losses. First, there is a provision for the losses arising on the closing of the L’eggs Australian subsidiary in the amount of SI.7M. Last year, LWR charged the establishment costs of this subsidiary as a loss “below the line,” also in the ambunt of ?1.4M. Thus the whole operation may have been charged below the line from its inception, although this is not clear.

Also below the line is the share of the extraordinary items of associated companies in the amount of ?IM. This could relate to closure costs of Bing Harris Sargood, referred to earlier, or perhaps it has something to do with the closing of Canterbury Canada. How the loss, if any, arising on the disposal of Canterbury Canada has been treated is not clear from the accounts and this is also true of a number of other disposals made in the year such as the sale of the company’s salmon-fishing venture, Tokoroa Fishing Industries, Ltd, the sale of 50 per cent of Onehunga Woollen Mills,

by LWR’s associate company and the sale of the company’s fishing vessel, the Cecilia Trosca. The assumption must be that they are all not material enough to require any specific disclosure and thus for it to matter whether they are placed “above or below the line.”

So which figure should investors rely on: the profit increment of 68 per cent; the profit increment of 0 per cent or the profit decline of 38 per cent. This is not an easy question to answer since the shareholder must make up his own mind about what is to be included above or below the particular line that he wishes to draw.

From his point of view the most important factor is that he gets adequate information on which to make his assessment. In LWR’s case the disclosure is fairly good, although I would like some further comfort about the termination of the other investments realised during the year. Clearly the attitude that one adopts for the extraordinary items is very important in the assessment of LWR’s year.

However, profitability alone is not the only factor in assessing a company, and one should also look at the liquidity and financial stability of a company as well — as shown by the balance sheet and the statement of changes in financial position — to seek answer to such questions as why the current assets and liabilities have risen sharply and why stock levels are up this year compared with previous years, and so on.